Brazil: Attitude Before Altitude, Part 2

What exactly is happening in Brazil?

Is it becoming an important place to do business, or an important place to study how business in the future will be done?

In our new three-part series, we look at attitudinal changes powering the huge growth in Brazilian renewable energy. In our last installment of the series “Attitude Before Altitude”, we looked at the rise of consensus on renewable energy across Brazilian society, and the impact of sustainable agricultural transforming, narrowing the climate impact while broadening the human benefit. In part two, we look at the changes in attitude at the policy and industry level.

The Brazilian ethanol market has much in common with its more well-publicized American twin. Both are based on first-generation feedstocks – Brazilian sugarcane and US corn. Both economies were hard-hit by a slowdown in capital markets, which frustrated the financing of capacity expansion. Both sugar and corn prices have increased sharply in the past 18 months, corn doubling, sugar almost tripling. Both had below-expectation harvests last year. Both see big growth in alternative fuels.

In the US, the Renewable Fuel Standard calls for 36 billion gallons of biofuels by 2022, up from around 14 billion today. In Brazil, there is no corresponding mandate, but the Brazilian energy ministry projects that ethanol production will reach 64 billion liters (16.9 billion gallons) by 2019-20, up from 28 billion liters today.

US and Brazil: vive la difference.

In the US, corn itself is a commodity, so processors are buying a commodity from growers and converting it to another commodity, fuel, plus distillers grains and possibly some corn oil. Not every processor makes ethanol in the US. Bottom line, growers dictate how much corn is available to processors and for the ethanol market (though they may be limited by contract, or by their own investment in ethanol mills).

In Brazil, processors are buying a raw material, sugarcane, from the grower, and converting it into either sugar, or ethanol (though processors themselves own plantations, there are tens of thousands of independent growers). Ultimately, the processors dictate how much cane is converted to ethanol. So, when commodity prices increased, there was a subtly different reaction.

In the US, when prices rose for corn, processors had exposure on the cost side, but rising oil prices kept ethanol prices on the rise, too. As long as processors could manage to maintain their margins, or “crush spread”, they were fine. But it was easier to pass along price increases into the fuel markets, which had a mandated volumetric requirements and high oil prices, than the food and feed markets.

In Brazil, when prices rose for sugar, processors did not necessarily have the same cost pressures, because they were buying sugarcane from essentially a captive market of growers. But they had a revenue opportunity by shifting their production ratios away from ethanol, and towards sugar. It was easier to pass along price increases into the sugar market than the ethanol market, as the sugar price was rising faster than oil. Fuel production was further hurt by the lighter than expected harvest.

End result? Ethanol shortages emerged in the Brazilian fuel markets, which prompted increases in imports from the US, and a sharp jump in prices. Anhydrous ethanol jumped 50 percent in the months of March and April (the rainy season, in between the sugarcane harvests) when stock ran low.

So the crisis was experienced differently in the two markets.

In the US, the “food vs fuel” debate revived as cattle and food producers sought to lift ethanol supports that, in their view, was the easiest road to relief from high corn prices.

In Brazil, an available option is to increase production. The approved zone in the overall Brazilian agricultural plan allows 64 million hectares for sugarcane cultivation, of which only 9 are planted. But the industry lacks borrowing power for expansion.

So, in the US, differences sharpened over ethanol, and neither side offered much relief to consumers on fast rising prices at the pump. At best, less ethanol could mean lower meat prices offset by rising gasoline prices; maintaining ethanol production, by contrast, could hold down (but not further relieve) fuel price pressures.

An Opportunity for Consensus

But in Brazil, an opportunity for consensus emerged.

To reduce fuel prices, production could be increased. To increase production, the government could intervene to provide lines of credit and other incentives. But here’s the catch – the government did not want to incentivize the industry, as currently structured, and then see all that production turned into sugar and sold into the world market. Good for Brazilian sugar exports, but bad for World Trade Organization complaints, and no help for domestic fuel prices.

So, when the industry knocked on the government’s door (well, that’s the government’s story) last year to ask for help in financing expansion of production, the government ultimately proposed an arrangement.

Would the sugar growers accept regulatory oversight – designed to ensure that help for their industry would be directed towards increasing fuel production? It would be an historic expansion of government regulatory power – for ANP, the governmental fuel regulator, had oversight of ethanol distribution but not production. Ethanol production had remained unregulated.

Now, in Brazil, traditional fuel is regulated. Interestingly, biodiesel is regulated on both a production and distribution basis. The goal? To ensure that public sector support for the industry’s growth would increase ethanol production and reduce prices at the pump, rather than increase sugar production. As one government official noted, “sugar has been around here for 500 years and can finance itself.”

Meanwhile, to meet the enormous growth in energy demand expected over the next 10 years, as many as 100 new distilleries will have to be built, each crushing an average of 3 million tons of cane per year.

OK, sugarcane expands – what about land use change, what about the Amazon?

What will prevent that expansion in production from causing disruption in the cattle industry, I asked – or deforestation in the Amazon?

“Cattle producers are going to have to concentrate their holdings,” explained the Energy Ministry’s Deputy Administrator for Renewable Fuels, Marlon Arraes Jardim Leal. “The days of one head of cattle per hectare need to evolve into a system of concentration and efficiency.” By contrast, sugarcane yields 75 tons per hectare per year on average, and 5,000 liters of fuel.

The Amazon? A friend explains. “There are two things that will change in the Amazon. First, the requirement that every land-holder reserve 80 percent of their holdings as permanent conservation land will be enforced. Second, the land title issues will be resolved, so that we known who owns the land. By 2019 there will be no deforestation in the Amazon, that is the consensus, that is agreed by the country now.”

Attitude Shift

There’s that consensus again. What happened? Years of building more trust between government and industry paid off. Not to over-simplify a complex, evolving relationship into an industry-government love in. Private industry remains wary of regulation, while government officials tend to see private industry wanting a free hand in good times, and government bailouts in bad times.

But relations, and the prospect of an enduring public compact that promotes stability and reduces uncertainty, has industry thinking hard about the trade of regulation for stability, as long as it brings policy stability too. So, in the ethanol industry, processors looked at the opportunities for increased production, and a more stable market, and weighed the risks associated with more regulation.

President Rousseff herself waded directly into the debate.  She reportedly told UNICA, the association of sugarcane growers, “as long as you are treated separately, you will remain small.” Since 2005, when the US energy policy was passed, she had seen an opportunity for the renewable fuels industry to become something else. At the time of the US bill’s signing, she told ministry staff, “this is a very strong sign – now we can get big.”

With some concerns, primarily concerning exports, industry consented to the arrangement. As Jacyr Costa Filho, the CEO of Guarani, the fifth largest sugar and ethanol producer put it, “I agree, the new arrangement will promote investment into the sector”.

In the US, there’s less trust between regulators and industry. Congress, prompted largely by industry concerns, is considering a repeal of portions of the Clean Air Act to ensure that the EPA dials down oversight of carbon dioxide emissions. Another bill in the Congress calls for the merger of the EPA into a combined Department of Energy & the Environment, which might put a regulator at the head of the combined department, or it might put an oil executive there.

Trust between the Brazilian energy ministry and industry was a long time in building. A number of years ago, virtually all energy planning was done by Petrobras and Electrobras, and policy oversight was at regulatory agencies, and there was only a skeleton staff doing any policy direction at Energy at all.

As they say in Brazil, “the authority pen was flying around the room”.

Lula and Rousseff

It was the current President and former chairwoman of Petrobras, Dilma Rousseff who, when she became energy minister in 2002, began to re-establish a stable, independent policy and planning function at the Ministry.

With one difference from the past. The technical staff of engineers and economists is now free of political appointees. It wasn’t always the case.

As Marlon Arraes Jardim Leal, explained it, “in the end you have to get a consensus with the Ministry of Finance on your plan. I would love to work there for one day. They get to say no to everything. It would be very nice to go over there with ‘renewable energy is very beautiful, and it will be very good for the people, this policy,’ but they are simply going to say no, we don’t have the budget. You need a very strong case, and that’s why  the President, when she was in the Ministry, built up a group of technical policy administrators. And subsequent energy ministers have continued with that, so there’s continuity now.”

Rousseff is respected, even admired, in Brazil, but she’s harder to love than her predecessor, the hugely popular Luiz Inácio Lula da Silva. Known everywhere simply as “Lula”, he departed office last year with an 80 percent approval rating and a reputation for powering consensus, and stability flowing from that consensus, that most observers say they had not seen before.

It was a reputation that Australia’s Bob Hawke had early in his prime ministership in the 1980s as the country realigned its policies and prepared for the growth spurt it is experiencing; Eisenhower had a similar reputation in the Second World War and into his US presidency. It’s rare.

How to describe Rousseff’s reputation? Well, on a recent visit to an electric car research center, a female VIP had some difficulty in finding restroom facilities for women. “Good thing the President wasn’t here, someone might have lost their job” a colleague observed. She’s become known for, shall we say, a Steve Jobs-like combination of smarts and decibels.

“That’s just her way,” said a different colleague from her energy days, “you have to see beyond that.” There are a lot of believers in the Brazilian model prepared to ‘ see beyond that’.

Milas Evangelista de Sousa, who oversees Petrobras’ ethanol partnerships including the stake in ten ethanol plants in Brazil and Mozambique, said “I will be 50 this year. The country has experienced crisis after crisis – hyperinflation of as much as 1000 percent. Always we heard that ours was the country of the future. Finally the future is here, it’s a period of great opportunity.”

It’s a common theme in bioenergy, which has experienced fast growth around the world, but has prompted far more debate and less consensus-building dialectic in, say, the US or Europe, than in Brazil.

A cautionary tale

A Brazilian friend cautions me about the Brazilian experience with ethanol. “You have to remember, here in Brazil, the economy is less diversified, we are more exposed to commodity prices. The impact of a successful energy policy translates into personal impact for people a lot more quickly than in the US. There, its not as easy to see the change in lifestyle when a major energy project is completed.”

I told him that I had seen similar social impact from renewable energy development in Iowa, just as in Brazil. By contrast, oil production generally, these days, goes offshore, and it doesn’t impact any surrounding community except perhaps the port city. And it can devastate regions, such as Port Harcourt in Nigeria.

We spoke at some more length about the differences between the Brazilian and US renewable fuels experience, and I asked him why he thought there was so much acceptance of ethanol as a fuel in the Brazil, compared to the controversies in the US. “It wasn’t always that way. When the Pro-Alcool program was started in the 1970s, it was the military and they were concerened only about energy security. Climate change, economic development weren’t even on their minds. It was a policy from the right, the conservatives. There’s some of that feeling that lingered for a long time about the sugarcane plantation owners, that they were somehow benefiting more than the society as a whole. Well, the right is pretty much gone for now in Brazil. In the last election, all the candidates were pretty much somewhere along the left side.”

And when did attitudes change?

“When did attitudes change? It was 2003, really,” my friend continued. “There had been a build up in the 1980s of ethanol-only cars, but it almost all went away in the 90s when oil prices dropped. Then we had an energy crisis in the early 2000s, and in 2003 the flex fuel cars appeared.

“You realize, ethanol has been blended into gasoline for more than 30 years here, and right now it is between 18 and 25 percent. So there’s a certain share that ethanol has, that drivers have no choice about.

“But ethanol has a majority of the market share. That’s because of the flex fuel cars, which run any combination of ethanol or gasoline, and there’s ethanol or gasoline at every pump. It really comes down to price, and whether you want a renewable fuel, or not.”

So, does Brazil really want renewable fuel? Or was it a convenience borne of a lot of sugarcane capacity and not much oil production. Will high sugar prices, and recent oil discoveries off the Brazilian coast, change all that?

Will Brazil become an oil giant, or a renewable, sustainable giant?

“Petrobras is in an unusual situation,” my friend told me. “It’s always been seen by people as basically an oil company, and now it has these large oil discoveries.  What will happen – we have been on the renewable energy track and now there is all this oil. How should we act? WIll we go back to being like other countries with a lot of oil?

“Now, Petrobras is a public company, listed on the Sao Paulo exchange. But the government has a golden share. So, the government has, shall we say, reorganized Petrobras’ thinking. To ensure that bioenergy is moving forward with investment from Petrobras. At the same time there’s a feeling that Brazil will get it right, will learn from the past and not repeat the old colonial times, or an exploitation for the benefit of a few.

“There is a social dimension to everything here – that is the consensus.”

And with that, my friend and I came to a point where we had to part ways. I asked him for directions. Which way should I turn at the next intersection, to the left or right?

“Here in Brazil, usually to the left,” he said with a smile. “But in this particular instance, you’ll turn to the right.”